On the Money: Investors lose patience with US shares but it's a good time to buy

By Michael Coote

Friday 16th August 2002

Fund flows out of US equity funds (mutual funds) hit $US18 billion in June, with worse expected for July and August, the Economist magazine reported last week.

Such numbers dwarf the net funds flow out of New Zealand managed funds over the same period.

This year seems to be shaping up as the first of net mutual funds redemption in the US since 1998.

The last big outflow was $US29 billion in September 2001 after the World Trade Center attacks but the redemption pattern of 2002 appears to be more prolonged and not so event-specific.

The pattern reverses the picture for 2000 and 2001, when funds inflows into equity funds generally increased month by month.

Mutual funds investors, usually the long-haul type of committed investor, are losing patience with US shares.

US investment bank Merrill Lynch has calculated that the breakeven point for an investor who put money into the US sharemarket monthly since 1990 is 776 points on the Standard & Poor's 500 composite index, provided returns match the index.

The S&P 500 is close to the breakeven barrier.

A lot of investors must have moved from seeing profit vanish to watching capital evaporate.

Pressure to sell must be rising as investors meet their thresholds of pain, especially when under US tax laws capital losses on investments are tax deductible (the reverse side of capital gains tax).

Ructions in the US sharemarkets have flowed across to others, with sell-offs out of the UK, the rest of Europe and Japan.

Index graphs for these sharemarkets are remarkably correlated to those from the US, which indicates the bear market is uniform across all the major bourses.

Low correlation expected between major economies - a strong argument for global investing - is on the wane in the current global bear market.

New Zealand investors will be feeling the pinch as foreign investors exit mutual funds and pull down share prices further.

Is disaster at hand? Not so, thinks the Economist.

If anything, the burst of fund redemption could be a sign that the corner is being turned.

The magazine quotes research by the Investment Company Institute, which claims that since 1943 periods of net redemption have been fairly brief.

In many bear markets - 1966, 1969, 1973-4, 1977 and 1981 - redemptions in fact slowed, although new purchases slowed further.

In the last two years there have been three big bursts of redemption, but in two of them, March 2001 and this year in June 2002, mutual funds were also heavy buyers, according to Strategic Insight.

Cheap shares look like bargains to fund managers and they can often redeem out of cash holdings and incoming automatic payment investments instead of selling shares.

In the post-September 11 mini-crash, only a third of share sales were driven by fund redemption.

The Economist quotes Steve Leuthold, a fund manager and market analyst in Minnesota, as saying, "Historically, the public has done the wrong thing both at stockmarket peaks and stockmarket bottoms."

What he means is that investors stuff too much money into equity funds near market peaks and suck too much out at market bottoms.

For example, record sums went into mutual funds in the first quarter of 2000 just before the present bear market began.

The previous record was set at the crest of the 1996 bull market.

By contrast, the biggest redemption periods so far took place in 1981 just before a bull market began and in 1987 after the crash, a point at which shares were bargains and another bull market started.

New Zealand investors may take comfort in the surge in US mutual equity fund redemption if it signals the beginning of a new bull market.

Weak sellers are being flushed out but for every successful seller there must be a matching buyer, indicating strong appetite to acquire shares at present.

Certainly, it seems fund managers are keen buyers of US shares at the same time as redeeming investors are pulling out.

The pattern suggests informed purchase and uninformed disposal.

Of course, the wrong time to sell is at or near the bottom and the way to make a paper loss into a real loss is to sell out.

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